Sheryl and Yekutiel Wultz say Israel promised to help them sue the Bank of China for funneling money to Palestinian terrorists. Why is Bibi backtracking?

The headquarters of the Bank of China in the Xidan district of Beijing on May 8, 2013.(Mark Ralston/AFP/Getty Images)

In 2006, Daniel Cantor Wultz, a 16-year-old from Weston, Fla., was killed along with 10 other people after a suicide bomber detonated himself at the Rosh Ha’ir shwarma stand near the Tel Aviv bus station. The Palestinian group Islamic Jihad took credit for the bombing, but they weren’t the only ones responsible: As far as Israeli officials were concerned, responsibility also lay with entities like the Bank of China, which the Israelis believe acted as a conduit for the cash used to carry out the attack.

Because Wultz was the only American among the victims, the Israeli government, under Ehud Olmert, encouraged Wultz’s parents, Sheryl and Yekutiel, to file suit in U.S. federal court claiming damages. Last year, Ron Dermer—Netanyahu’s American-born senior adviser and, as of next month, Israel’s new ambassador to Washington—provided the Wultz family with written assurances that Israeli officials would testify. According to the Wultz family’s lawyer, Lee Wolosky—who worked in the White House as a counterterrorism official under both Bill Clinton and George W. Bush—those guarantees were instrumental in convincing the family to proceed with the case.

But now, six years later, the lawsuit may have been dealt a fatal blow by Israel’s own hand. Earlier this year, with his May visit to China looming, Prime Minister Benjamin Netanyahu apparently succumbed to pressure from Beijing to prevent a former Israeli intelligence official, Uzi Shaya, from testifying in the Wultz case. According to reports in Yediot Ahronot and other outlets, Beijing threatened to cancel the Sino-Israeli summit unless Netanyahu blocked Shaya from testifying.

For Netanyahu, visiting China was a crucial step in advancing Israel’s burgeoning commercial and political relationship with the Asian superpower, a strategy the Israeli leader has strongly advocated over the past year. In failing to stand by his government’s promise to support Daniel Wultz’s parents in their lawsuit, Netanyahu is not only sidestepping the war on terror but is also attracting the ire of his congressional allies in Washington, who accuse him of siding with China over the United States at a time when relations between Beijing and Washington are strained over issues of cyber-security and intellectual property theft. Israeli officials’ bungled efforts to balance their competing interests over the course of this lawsuit suggest that Israel has been remarkably maladroit in navigating between its oldest ally and its newest friend—and in handling the grieving parents who have been put in the middle.

“I don’t have to be in Netanyahu’s shoes,” Yekutiel Wultz toldHaaretz. “I know one thing—Israel failed to protect us when we were there in 2006. And yet when they came and wanted our help in filing the lawsuit and stopping terrorists, we gave our hearts and souls to this.” Sheryl Wultz told the Wall Street Journal, “If the Israeli government withdraws support for this case, it would be another tragedy on top of a tragedy.”

The federal judge overseeing the case, Shira Scheindlin, has imposed an Aug. 31 deadline for Shaya to testify. The Israeli Justice Ministry has not communicated with the court since sending an ambiguous letter on July 12. Israeli officials in Jerusalem did not respond to requests to comment on this story; China’s Embassy in Washington and lawyers for the Bank of China, which has denied the allegations, also declined to comment.

Lawyers say the Wultz case and five related lawsuits pending in New York federal and state court against the Bank of China are hanging in the balance of Netanyahu’s decision. “Shaya’s testimony will bury the Chinese,” said Nitsana Darshan-Leitner, an Israeli attorney whose legal-advocacy center Shurat HaDin is representing families of victims of terror attacks in Eilat, Jerusalem, and Sderot in cases related to the Wultz litigation. “But without it, success in the case is far from certain.”

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In 2005, Israeli intelligence officials met with Chinese officials and informed them that Iran and Syria were using the Bank of China to funnel millions of dollars to Islamic Jihad and Hamas. According to the Israelis, the money was routed through the bank’s branches in New York and the southern Chinese city of Guangzhou and then transferred to Gaza by a Palestinian based in Guangzhou named Sa’id al Shurafa.

When the Chinese refused Israeli requests to close the accounts, the Israelis turned to the Wultz family and Shurat HaDin. Israel’s relations with China at the time were strained due to Jerusalem having recently canceled two major arms deals with Beijing under heavy pressure from Washington. After the second diplomatic debacle in 2005, Israel salvaged ties with the Pentagon by agreeing to suspend future arms deals with China. With no partner in Beijing, Israeli security officials focused on cutting off Iranian funding to Hamas, blithely ignoring the potential diplomatic fallout of challenging one of China’s flagship financial institutions in a public court of law.

Lawyers for the Wultz family and for Shurat HaDin initially believed that the Chinese bank would seek an out of court settlement, following the example set by English banking giant Standard Chartered, which paid the U.S. government $330 million in August 2012 to resolve allegations of hiding billions in illegal transactions with Iran. In believing that the Bank of China would act accordingly, the lawyers seriously underestimated the resolve of the Chinese bank. Rather than seek a face-saving settlement, the bank has aggressively sought to delay and defeat the case against them. After failing to win a dismissal of the case in 2010, the Bank of China assembled a team of more than 30 lawyers who threatened to file defamation suits against the plaintiffs. According to unconfirmed reports in the Israeli media, the bank also offered to provide Israel with an unprecedented $3 billion loan so Netanyahu could tackle the country’s urgent housing crisis—and in return, expected him to block Shaya’s testimony.

Last year, the prime minister’s office tried to backtrack on their promise to allow Shaya to testify—until Eric Cantor, the House majority leader and a first cousin of Sheryl Wultz, called Dermer and berated him for this breach of trust, prompting him to provide emailed assurances to the Wultz family that Shaya would appear in court. The Wultz family also says Michael Oren, Israel’s current ambassador to the United States, repeatedly promised them Shaya would testify. In the meantime, the Wultz family won a $323 million judgment in May 2012 in a similar case they filed against Iran and Syria.

As recently as March 20, Shaya signaled to the court that he was ready to testify. Word of Shaya’s forthcoming deposition arrived just as the Bank of China was reeling from a series of damaging court orders that forced the Chinese bank to provide a range of private bank materials, including internal communications between the bank and the Chinese government. Beijing responded by informing Netanyahu that his visit to China in May would be scrapped if Shaya testified in New York. Since Prime Minister Ehud Olmert’s visit to Beijing in January 2007, and especially since 2010, Sino-Israeli relations have rebounded; the trade relationship was worth more than $8 billion in 2012. After several failed attempts to visit China in 2012, Netanyahu’s impending visit was viewed with the utmost importance in Jerusalem.

Beijing’s actions left Netanyahu facing a difficult decision. Would he stand by Israel’s pledge to terror victims and key political allies in Washington? Would he live up to the stirring words he declared in front of the United Nations in September 2009, promising to fight Iran’s support of terrorist groups? Or would he take advantage of an opportunity to usher in a strategic—and profitable—change in Israel’s relationship with China? Netanyahu chose China, wrapping up a six-day visit to Shanghai and Beijing in early May that Chinese officials described as “determining the direction the relationship will take in the coming years, elevating ties to a new level.”

Netanyahu’s decision to block Shaya’s testimony met with a stinging rebuke from Daniel Wultz’s parents and their allies in Washington, including Florida Rep. Ileana Ros-Lehtinen, a Republican who chairs the House Foreign Affairs subcommittee on the Middle East. Meanwhile, other members of Congress complained to Haaretz, anonymously, that Netanyahu’s office was refusing to answer their phone calls.

Still, Netanyahu has so far avoided paying any real price for succumbing to Chinese pressure. With the renewal of peace talks this month, the Obama Administration has too much invested in maintaining diplomatic calm to take the Israeli leader to task for interfering with an American court case. Netanyahu may have even been counting on the American peace process to provide him with the necessary political cover to side with China over American interests. After all, the Chinese were pressuring Netanyahu to stop Shaya’s testimony in early April, just as U.S. Secretary of State John Kerry was meeting with the Israeli leader. And Israeli audiences have ironically been distracted by a separate instance of Netanyahu sacrificing justice on the altar of national interest: the prime minister’s recent decision to release Palestinian prisoners as a prelude for relaunching the peace process.

In any event, the clear lesson from this wretched chapter in Israeli diplomacy is the degree to which Israel’s policy on China has been mismanaged from day one. Israeli officials created this problem for themselves, when they misjudged the degree to which the Bank of China and its government supervisors would take offense to being labeled in American court as bankrolling terrorism. In many ways, Israeli officials followed the same mistaken script of the arms-sale scandals from a decade earlier where Chinese policy was set by security officials who ignored predictable political concerns in the United States and China over Israel’s sale of advanced weaponry to China. Those scandals ended with Jerusalem tarnishing its credibility in Washington and Beijing and sacrificing a profitable arms business with Beijing to mend fences in Washington.

What should be of even greater concern for policymakers in Jerusalem this time around is that this latest instance of Israel’s short-sighted China policy was brought to crisis point by Beijing rather than Washington. And unlike American diplomats, Chinese officials in this case showed no interest in resolving the dispute peaceably. In insisting that Israel bend to China’s diktat, Beijing demonstrated the same authoritarian tendencies that are increasingly on display in China’s more assertive foreign policy.

Netanyahu wrapped up his visit to China on May 9 by establishing a new inter-ministerial committee that will streamline Israeli policy on China and expand direct communication with Chinese leaders in Beijing. To avoid having to choose between the United States and China in the future, Israeli leaders better hope that the new China committee will produce policies that are more far-sighted and informed than is being demonstrated by the government’s conduct toward the case on trial in New York.

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Sam Chester is an expert on China-Middle East affairs, managing technology funds for investors in China, Europe and the Middle East.